2009 UpdateReal-Life Retiree Investment Returns

This article was first posted on July 1, 2002, updated on May 1, 2010.

Looking back over the past fifteen years, I thought it might be interesting to see how some popular investment strategies have fared since I quit work in November 1994. During that time, we've seen a five year bull market, a three year bear market, and another bull market where the S&P500 and Dow reached new all-time highs in October 2007. In the past 30 months we've seen another 50% plunge in stock values followed by a significant recovery. The NASDAQ continues to lag at less than one-half its year 2000 peak. The good news is that anyone with a reasonably diversified portfolio did just fine. It's not bad news, but, of course, some strategies performed better than others. The chart below shows the results for a $100,000 starting balance and a 4% of assets initial withdrawal indexed annually for inflation. Vanguard index funds are used whenever possible in this analysis. If you want to check the calculations, you can download the Excel spreadsheet, click here.

All portfolios showed gains for 2009. The biggest winner was the Harry Dent portfolio with a 33% annual gain. The Warren Buffett portfolio had the weakest performance with only a 3% gain in 2009. It fell to second place over the fifteen-year period behind the Harry Dent portfolo. The three broadly diversified portfolios (Retire Early, One-Fund, and MPT) are grouped in the middle, while the 100% fixed income portfolio is in last place, lagging badly over the fifteen-year period.

Inflation as measured by the CPI-U was up 2.63% in 2009. A big increase over 2008 when inflation was essentially flat, showing just a (0.03%) three-hundreths of one percent increase for that year.

If we adjust the table and plot above for inflation and show the results in constant dollars, the December 31, 2009 portfolio values are reduced by about one-third. While both the Harry Dent and Warren Buffett more than doubled in inflation-adjusted terms, the other three equity-based portfolios only showed a 34% to 42% gain. The 100% fixed income portfolio lost 18% of its value in constant dollar terms over the past fifteen years.

Most of the various safe withdrawal studies done over the years assume some combination of an S&P500 index fund and fixed income assets. While the Retire Early study used 3-month commercial paper for the fixed income allocation, most retirees only keep one year's worth of expenses in a money market fund and the balance of their fixed income allocation in a ladder of CDs or bonds. To more closely model retirees' actual practice, an allocation of 4% of assets to Vanguard's Prime Reserve Money Market Fund (VMMXX) and 21% to Vanguard's Short-Term Corporate Bond Fund (VFSTX) was used for the 25% fixed income allocation.

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

Retirees following this approach over the past fourteen years have been generally pleased with the results. Even after taking fifteen years of inflation-adjusted withdrawals of more than $70,000, the account balance has grown to $205,379 as of Dec 31, 2009. The 25% fixed income allocation has also grown from 6.25 years' worth of annual withdrawals to 8.90. The Jan 2010 withdrawal of $5,767 amounted to just 2.81% of assets.

2. One Fund Portfolio (Vanguard Balanced Index Fund (VBINX))

If even annual rebalancing of your retirement portfolio sounds like too much of a job, Vanguard's Balanced Index Fund may be a solution. The fund maintains a 60% allocation to the Wilshire 5000 Index and 40% to the Lehman Aggregate Bond Market Index. The expense ratio is 0.25%.

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

Retirees following this approach over the past fifteen years have been generally pleased with the results. Even after taking fourteen years of inflation-adjusted withdrawals, the account balance has grown to $205,058 as of Dec 31, 2009. The 40% fixed income allocation has also grown from 10.00 years' worth of annual withdrawals to 14.22. The Jan 2010 withdrawal of $5,767 amounted to just 2.81% of assets.

3. 100% Fixed Income

Some retirees just can't stomach the ups and downs of the stock market and prefer to keep all their retirement assets in fixed income securities. Few experts advise this, but folks do it anyway. Over the past fifteen years the 100% fixed income portfolio has stedily lost purchasing power to inflation and remains in last place overall. The January 2010 withdrawal amounted to 4.87% of assets. An allocation of 4% to Vanguard's Prime Reserve Money Market Fund (VMMXX) and 96% to Vanguard's Short-Term Corporate Bond Fund (VFSTX) was used for this all fixed income approach.

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

Two prominent early retirees have followed the 100% fixed income approach. Your Money Or Your Life author Joe Dominguez invested in only US Treasury securities when he retired in 1969 at age 31 and continued to champion that approach up until his death in 1997. Dominguez retired in 1969 with a $100,000 portfolio and $7,000 per year in living expenses. An August 1996 Kiplinger's Personal Finance Magazine article revealed that Dominguez was then living on about $13,000 per year. To keep pace with inflation, $7,000 in 1969 would need to grow to $30,360 by 1996 to maintain the same purchasing power. Dominguez managed this loss of spending power with unusual living arrangements (he lived in a group home with about 30 other people) and a lot of composting and the washing and reusing of tin foil and wax paper -- a strategy that few early retirees would tolerate.

Paul Terhorst, author of Cashing in on the American Dream: Retire at 35 limited his investments to a laddered portfolio of FDIC-insured Certificates of Deposit (CDs) when he retired in 1984. His web site ( http://www.geocities.com/TheTropics/Shores/5315/ ) reveals he holds "a more traditional portfolio heavily weighted with low-cost [equity] index funds" today.

Modern Portfolio Theory (MPT) holds that wide diversification among different asset classes increases investment returns. It was first advanced in the early 1950's by Princeton University Professor Harry M. Markowitz. He won the Nobel Prize in Economics in 1990 along with William F. Sharpe and Merton Miller for his work in portfolio diversification and investment returns. In recent years, author William J. Bernstein has popularized these concepts in his book The Intelligent Asset Allocator and on his web site http://www.efficientfrontier.com. Even Vanguard founder Jack Bogle recently relented and suggested that investors allocate "up to 20% of their stock market money to foreign shares." (Wall Street Journal, March 07, 2007)

To illustrate an MPT portfolio the nine-asset class Bernstein-inspired portfolio described in a December 2000 Smart Money magazine article was chosen. This portfolio covers the gamut from large cap to small cap US stocks, international equites, emerging markets, REITs, and short term bonds. The 40% allocation to Vanguard's Short-Term Corporate Bond Fund (VFSTX) was changed to 36% VFSTX and 4% Prime Money Market Fund (VMMXX) to provide the one year's worth of expenses in a money market fund that most retirees maintain.

(1)....Dollar value of 4% of assets initial withdrawal indexed to the CPI-U in future years.(2)....Annual withdrawal as a percent of previous year's Dec 31 balance.(3)....Years' worth of annual withdrawals in fixed income assets (based on previous year's Dec 31 balance.)

While the MPT portfolio value has trailed the simple S&P500/fixed income portfolio (No. 1 above) by 6% as of Dec 31, 2009, advocates of this approach like its reduced volatility and sterling academic recommendations. Which brings us to an important investing truism -- it's OK to under perform as long as you're pleased with the results and proud of what you are doing.

The efficient market theorists don't like it, and warn that it's too risky, but many investors eschew index funds and hold individual stocks or concentrate on one or more industry sectors. Most of the research I've seen shows that no more than 20% of the people who hold individual stocks out perform the S&P500. If you're a member of this minority, obviously you're pleased. Here's a couple of concentrated portfolios I've followed over the years.

5. Warren Buffett Portfolio (BRKa/Fixed Income)

Warren Buffett fell to number 3 on the list of world's richest people in 2010, though he's hardly hurting with $47 billion of his remaining wealth intact. It's even more noteable that he's one of the few members of the Forbes 400 who got there by investing in stocks rather than founding a successful business or inheriting his fortune. His investment strategy is to buy and hold positions in a few companies and watch them very carefully. Four stocks (American Express, Coca-Cola, Procter & Gamble, and Wells Fargo) make up more than half the value of Berkshire's $59 billion stock portfolio.

Berkshire Hathaway's Investment Portfolio (as of Dec. 31, 2009)

Shares

Company

Cost

Market

.

.

(dollars in millions)

151,610,700

American Express Company

$ 1,287

$ 6,143

225,000,000

The BYD Company, Ltd.

232

1,986

200,000,000

The Coca-Cola Company

1,299

11,400

37,711,330

Conoco Phillips

2,741

1,926

28,530,467

Johnson & Johnson

1,724

1,838

130,272,500

Kraft Foods

4,330

3,541

3,947,554

POSCO

768

2,092

83,128,411

The Procter & Gamble Company

533

5,040

25,108,967

Sanofi-Aventis

2,027

1,979

234,247,373

Tesco

1,367

1,620

76,633,426

US Bancorp

2,371

1,725

39,037,142

Wal-Mart Stores, Inc.

1,893

2,087

334,235,585

Wells Fargo & Company

7,394

9,021

.

Others

6,680

8,636

.

Total Common Stocks

$34,646

$59,034

For the purposes of a retirement portfolio, a mix of 75% Berkshire Hathaway stock, 4% money market fund and 21% short-term corporate bond fund was chosen for the example below. Through December 31, 2009, the value of the Warren Buffet portfolio exceeded the S&P500/fixed income portfolio by 49%. .

Harry Dent made perhaps the most prescient forecast of the great bull market of the 1990's in his 1993 book The Great Boom Ahead. His theory of demographic investing sees the Dow Jones average hitting 41,000 by the year 2008. (He revised that to a Dow of 20,000 in late 2006, click here.) The chart below summarizes Dent's long-term forecast.

Dent favors three sectors of the economy during the 1982-2008 boom: technology, health care, and financial services. More troubling is the 12-14 year long recession/depression from 2009 to 2022. The deflation during that period will make long-term US Treasury securities the investment of choice.

Three sector funds were used to build the Harry Dent portfolio below. The Vanguard Health Care Fund (VGHCX) was chosen for its low expense ratio. Since Vanguard doesn't offer similiar specialized funds in other areas, the Fidelity Computer Technology (FDCPX) and Financial Services (FIDSX) sector funds were selected as a convenient choice.

There's no shortage of losing strategies you could have employed over the past fifteen years. Market timing, day trading, Internet stocks with no record of earnings, etc. likely would have lost you money unless you were one of the fortunate few who sold out at the top. Retirees who see the value in holding at least 5 years' worth of expenses in cash and CDs and maintain some level of diversification in their portfolios would have rejected most of these losing investment approaches on principle alone.

What if you retired in January 2000?

If you happened to retire in January 2000, the last ten years haven't been pleasant. Only the Warren Buffett portfolio has a value appreciably exceeding its $100,000 starting balance. The 100% fixed income and MPT portfolios are just above water. The other three portfolios all show losses. The worst performer was the 75% S&P500/25% fixed income portfolio which is now only about 60% of its starting value . The chart below illustrates this performance.

What to conclude from these results? There's a reason Warren Buffett is regarded as the most successful stock market investor of all time.